The past year has not been pleasant for Centrica (CNA) investors, but we think that offers long-term investors an attractive opportunity. The stock reached an all-time high of £4.02 per share in September 2013 and then fell almost 25% by February 2014. Although the share price has modestly recovered, it is still trading 20% below the year-ago high and 13% below our £3.70 per share fair value estimate.
Almost everything has gone wrong for Centrica this year. Retail supply margins have compressed, U.K. politicians want to cut energy prices, forward commodity prices are flat, spark spreads remain depressed, its nuclear plants are struggling, and, there was a polar vortex in the mix. Combine these problems with a complete turnover of Centrica's senior management and it is not surprising that investors fled.
However, we think the underlying problems are short-term and cyclical, not structural. We also think the dividend is secure despite weak 2014 earnings and an elevated pay-out ratio. Altogether, we think this is an opportunistic time to pick up Centrica while it yields 5.3% and trades at just 11.5 times our normalised 2017 earnings estimate, a sharp discount to its peers and the market.
Centrica remains the market share and pricing leader in the U.K. residential energy supply market. Its 38% and 24% market shares in natural gas and electricity supply, respectively, are solidly ahead of other retailers. Although 2014 after-tax profit margins are expected to decline to 4%, down from 5% as recently as 2012, we expect normalized margins stabilise at 4.5%.
Centrica's Sabine Pass LNG contract gives it optionality value. Its long-term agreement to purchase 89 billion cubic feet per year of LNG from the Sabine Pass liquefaction plant in Louisiana is primarily to secure supplies for British Gas customers. However, the more international gas prices diverge from U.S. and U.K. gas prices, the greater value Centrica can create by diverting LNG cargoes elsewhere.
With higher taxes and increasing costs in the North Sea, Centrica is shifting its capital to North America. The company recently reported that the 2013 Suncor acquisition is ahead of its investment case, and it recently acquired a package of natural gas assets in Alberta with its Qatari partner. The company has a solid record of oil and gas property acquisitions.
Centrica's nuclear generation fleet is a wide-moat business. Despite recent operating problems, we expect its eight 20%-owned nuclear units will contribute steady and dependable operating profit for many years with its low-cost carbon-free generation.
